One of the biggest fallacies about last night’s post on Compounding Growth vs Investing Residual is that equity value doesn’t increase at a constant rate over five years. In reality, the valuation of a startup fluctuates dramatically based on internal and external factors, with two of the most common drivers being growth rate and scale for a Software-as-a-Service (SaaS) company (EBITDA is more important for most businesses).
Let’s take Pardot as an example startup, that while not normal, does demonstrate that growth in company value is not constant and compounding growth is amazing:
- March 2007 – Personally invest money at a $1.2 million pre-money valuation with only a business idea and a great cofounder (at this point, with a new business, the valuation is often more than it’s worth once it starts generating early revenue since there’s still a gap between reality and the dream of what could be)
- December 2007 – With a few paying customers and minimal revenue, the value was likely barely more than what it was at founding earlier in the year
- December 2008 – With about $400,000 in trailing twelve months (TTM) revenue, good progress was being made, but there weren’t any signs of breakthrough success. I’d peg the valuation at $2 – $2.5 million.
- December 2009 – With about $1.2 million in TTM revenue, great growth rate, and passing the magical seven figures of recurring revenue milestone, the valuation really jumped to somewhere in the $6 – $8 million range.
- December 2010 – With about $3.2 million in TTM revenue and all the desired metrics of a great SaaS business around gross margins, renewal rate, growth rate, lifetime value of the customer, etc, the valuation continued grow fast to somewhere in the $15 – $18 million range.
- December 2011 – With about $7.4 million in TTM revenue, growth on a relative basis had slowed but on an absolute basis had still grown, and the business was now past the next magical milestone of $5 million in revenue, and the valuation was likely in the $35 – $45 million range.
- October 2012 – With about $10 million in TTM revenue, clear separation of the market leaders from the rest of the pack, and absolute and relative growth rates increasing due to significant investment in sales and marketing at the beginning of the year, Pardot was acquired for almost $100 million by ExactTarget.
In this example, which is purely educated guessing using SaaS revenue as a basis, you can see the valuation not grow much in the first two years, then triple for a couple years in a row, then double yearly until the exit. Here, the amazing power of compounding growth is really at work.
What else? What are your thoughts on these Pardot valuation milestones and compounding growth?